Are reinvested dividends taxable in the UK? Sadly, yes. Fund accumulation units attract income tax on dividends and interest at the same rates as their more transparent ‘income unit’ cousins.
You owe dividend income tax (or income tax on interest in the case of bond funds) even though you don’t physically receive a payout to your bank account.
And the taxman still wants his cut despite many accumulation class funds showing zero dividend distributions on their webpages.
But it gets worse. Some investors are probably paying tax twice on their accumulation unit income, because they don’t properly account for the effect of dividends on their capital gains tax bill.
Let’s sort this mess out with a quick summary of the reinvested dividend tax rules.
++ Monevator minefield warning ++ Everything below applies equally to dividends and interest but we’ll mostly only refer to dividends because life is short. It also equally applies to accumulating / capitalising ETFs, as well as the accumulation units of OEIC and Unit Trust funds. We’ll pick out the occasional exception where it exists.
What are accumulation units again? And how do they reinvest dividends?
Many investment funds come in two varieties (or share classes) that differ only in the way they treat dividend payments:
- Accumulation units are the share class that automatically reinvests dividends or interest straight back into your investment fund.
- In contrast, income units cough up dividends directly, paying you cash like three cherries on a fruit machine.
You can tell how a fund reinvests dividends by checking its name:
- A fund name that includes the abbreviation Acc indicates the use of accumulation units.
- A fund that features Inc in its name sports income units.
Reinvested dividends increase the capital value of a fund composed of accumulation units. That has implications for capital gains tax. We’ll show you how to work this out below.
Meanwhile, dividends reinvested in your fund’s accumulation units are known as a ‘notional distribution’. This notional distribution is taxable – in just the same way as income units.
Tax on accumulation funds – when do you not have to pay?
You owe income tax on ‘accumulated’ dividends unless:
- Your (notional) dividend income is covered by your tax-free dividend allowance. Any dividend earnings above the allowance are subject to dividend income tax, regardless of the fact they’re rolling up in an ‘Acc’ fund.
- Dividend income is also tax-free where you have spare personal allowance – the level before you must pay tax on income. (Perhaps you’re a FIRE-ee who no longer pulls down a salary?)
- Interest income can be sheltered by your personal allowance, your ‘starting rate for savings’ and your ‘personal savings allowance’. (Ever wondered why accountants like our convoluted tax code?)
- If your accumulation unit funds are held within an ISA or SIPP then they’re legally off the taxman’s radar.
Do you pay capital gains tax on reinvested dividends in the UK?
You do not have to pay capital gains tax on reinvested dividends in accumulation units. You’re already paying income tax on those.
So when you come to fathom the capital gain on your accumulation funds (and as your resultant psychic scream reverberates around the universe), make sure you deduct any notional distributions from the total gain. Otherwise, the reinvested dividends inflate the value of your fund and you’ll overpay CGT.
Here’s the formula to correctly calculate capital gains tax on accumulation funds:
Capital gain = Net proceeds1 minus original acquisition cost minus accumulation income2 plus equalisation payments
Here’s a worked example for an acc fund sold for £20,000. It’s accumulated £500 income over the years since it was purchased for £10,000:
Net proceeds: £20,000
Less acquisition cost: £10,000
Less accumulation income: £500
Plus equalisation payments: £100
Capital gain = £9,600
If you haven’t received any equalisation payments from your fund then ignore that step. See below for more on equalisation.
You can also reduce capital gains if you owe excess reportable income.
Incidentally, if you switch from accumulation to income units then that is a chargeable event and may incur capital gains tax.
Equalisation payment effect on accumulation units
You’ll notice in the example above that accumulation income reduces your capital gains tax bill. Meanwhile, equalisation payments raise it.
Equalisation payments may be made by your fund when you purchase units between dividend payment dates.
They’re paid because part of your purchase price included dividends that inflated the capital value of the fund – before those dividends were distributed (or reinvested).
You weren’t entitled to the dividends that accrued before you invested. The equalisation payment is effectively a return of your capital. It cancels out the extra you paid on the purchase price due to the embedded dividends.
You don’t owe income tax on equalisation payments.
With accumulation units, treat equalisation as per the capital gains tax formula above.
The effect of dividends you weren’t entitled to is then cancelled out from your fund’s capital value.
Equalisation payments should show up on your fund’s dividend statements via your broker – after the distribution or at the end of the tax year.
You’ll receive multiple equalisation payments if you invest regularly in a fund with an equalisation policy.
Note: not all funds make equalisation payments.
Vanguard has published a guide on how to work out equalisation payments on its funds.
Accumulation unit dividends – how to find them
Of course, you can only make the necessary accumulation fund tax calculations if you’ve been recording the dividends you’ve received over the years.
And who doesn’t do that…?
The problem is accumulation unit distributions are more stealthy than income unit payouts. You don’t get to do a little dance every time those divis turn up in your trading account.
So where can you find out about them?
- In your dividend statements from your broker, if you receive them.
- Trustnet keeps a good account of accumulation unit distributions. Put your accumulation fund’s name in the ‘Find A Fund’ search box. Then click the dividends tab.
- In your fund’s annual report.
- Using Investegate’s advanced search. Set categories to ‘dividends’. Set the timespan to ‘six months’ or whatever suits you. Search for the company name of your fund. Enjoy!
Are accumulation units worth the hassle?
The main advantage of accumulation funds is to skip the cost and effort of reinvesting dividends.
This cost saving is rendered superfluous if your fund isn’t saddled with trading fees or a high regular investing minimum.
On the other hand, accumulating funds mean that your income is reinvested straightaway, without time out of the market or you having to lift a finger. That’s a godsend if you prefer the hands-off approach.
Some people prefer to hold income units when investing outside of a tax shelter. The dividend payouts can be used to rebalance, or to pay tax bills without you having to sell units and trigger capital gains woes if you breach your exemption allowance.
Whichever way you go, just remember that any accumulation units in your portfolio are not immune to income tax.
As (nearly) always, making full use of tax shelters – by investing within your ISAs and pension – saves you hassle as well as money, by enabling you to sidestep all the above malarkey.
But where that’s not possible, start recording those reinvested dividends.
You could do it just for the fun of seeing what you’re earning in income, even if you don’t have to pay tax on them!
Take it steady,
This is a really useful article. I have plugged that people read it in v1.1 of the Monkey with a Pin book.
Much obliged, Pete. Have got Monkey With A Pin on my ‘to read’ list.
Thanks for explaining this. It did spur me to think of a question however. If one had money in a fund with no fees for investing or withdrawing money (as I believe is the case with the HSBC trackers) then would it be possible to avoid income tax by selling shares in the fund just before the dividend paid out and purchasing them back afterwards. Given that the share price moves to reflect the dividend amount the fact that one has not received the dividend payment should not matter.
I am assuming here that this would all take place within one’s capital gains tax allowance and not incur any charges in this way.
Hey, LearnFrench. That sounds like a cunning ruse, but I worry that your shares could freefall after you’ve bought them back and you end up making nothing at all. Or, for whatever reason, the market spikes up before you get a chance to buy back and your short-play backfires on that count. I haven’t looked into this myself but my gut-feeling is that the real world makes it not worth the hassle. That said, I’d be very interested to hear from anyone who had tried this.
Somewhat cunning but I did think that it seemed rather too good to work myself. Does the ex-dividend fall in share price actually equal the whole dividend amount or is it perhaps a bit less to take into account income tax losses? Although given that there are different income tax rates I imagine that this could get complicated.
I’m new to investing (to date I’ve been a cash-ISA only man) but having had a good look at this website I’m really excited by the prospect of being a little more creative with my savings.
However! I must confess I’m still confused by the tax treatment (and since I’m a tax lawyer that’s a little embarrassing). I understand that the accumulation units (or shares in the case of OEICs) might pay out dividends and automatically reinvest them for you out of convenience. If that’s the case then surely you would have to pay tax on the dividends, you would have more shares / units in your portfolio, and your base cost would increase (so although you get taxed on the dividend, at least you don’t have to pay capital gains tax on that element further down the line).
But is that how all OEICs work? I’m specifically looking at the Vanguard Lifestrategy range of funds at the moment. Why would they pay out a dividend, and trigger tax, and reinvest it, when the money could simply stay in the fund and be reinvested without a tax charge on the individuals, which would then increase the capital value of the shares on which you pay CGT when you finally cash out.
Even after looking at the Key Investor Info for one of the Vguard LS range I’m confused. It uses phrases like “income from the fund will be reinvested” which to my mind is ambiguous.
Can anyone help?
I think I’ve answered my own question, but for the benefit of anyone who’s interested:
The key is that legally OEICs have a special tax regime.
It seems that if you have an equity fund (and painting with very broad brush strokes, this is a fund which doesn’t hold at least 60% of its assets in cash / gilts / similar approved investments, and very definitely not shares) then all of its distributions are treated as dividends for tax purposes AND (crucially) any income amount which is available for distribution by the fund (i.e. income from underlying investments) is automatically treated as if it were actually distributed, whether or not cash goes out to the shareholder. So this is why the fund doesn’t actually pay out a dividend and then reinvest it. The income is allocated to reinvest in the capital of the fund (without ever leaving the fund company) but is still treated as though distributed for tax purposes.
So that’s satisfied my curiosity. Anyone who is similarly curious can have a flick through the Authorised Investment Funds (Tax) Regulations 2006.
My understanding is that with ACC units, the number of units does not change, but the base cost should increase by the dividend amount. Was wondering if this increase is the net or gross dividend. And would the effective date of that increase be on the Ex or pay date? Any answers appreciated.
Very useful article. I have been investing small monthly amounts into an accumulating tracker fund since 2002, for the purpose of creating a college fund for my darling son. These were the days before junior ISA’s and child trust funds. I have kept the statements and tax vouchers, but never really understood the importance of the vouchers. It now seems that I have been a tax evader and if I want to offset capital gains tax when selling my fund ,when my son is 18 next year, I will have to tell the tax man about the accumulated dividends over the last 13 years.
Any thoughts on that ?
Your article says to deduct reinvested income from gain – I understand this but am not sure how much of reinvested dividends from accumulation fund can be deducted if only part of fund has been sold – and how much of these dividends have to be deducted from gain from future sales. Any help on this would be much appreciated.
In order to take advantage of the new £5,000 dividend nil rate band for both me and my spouse, I would like to transfer to my spouse’s trading account, as a gift, some of the holdings in my own trading account. I am thinking to transfer shares in Vanguard FTSE U.K. All Share Index A. The income version of this fund will next pay a dividend at 31 December 2016. My accumulation version has this dividend reinvested. What I want to know is: what do I need to do to be sure that the tax on the dividend is owed by my partner, rather than me. Does it make any difference whether I transfer the fund to his account early in the year, say 10 April 2016, or later in the year, say at 10 November 2016?
I am new to investing in the UK and have not yet seen how a UK tax reporting statement from my platform will look, so I do not yet understand how this works – if one owns shares in an accumulation shares of a fund for X% of a tax year, does that mean that one owes tax on X% of the annual dividend, or is it the case that the person who owns the shares at a certain point in the year (say when the income version goes ex-dividend) owes the tax on the entire dividend for the entire year? I hope you understand the question I am asking.
@ Richard – we could take our best guess but we’re not tax experts and I think that’s what you’d need for a definitive answer. It seems reasonable to me that your partner would be liable as long as the units are in their name by the time the dividend is paid (and the divi is announced for the acc fund the same as for the inc version) but that doesn’t mean HMRC would agree.
I am looking for the answer to Richard’s question (March 31 2016) – just wondering if he ever found out? Hopefully he might get an email if he is subscribed to posts on this page. If anyone else knows, would appreciate any pointers. Thanks.
Does anyone have info on Mervyn’s question from 2014 as I have the same question. I have accumulation units within an ISA and get info on accumulation fund distributions, but the number of units held does not increase. Just to complicate things I am in Canada and ISAs are not tax-free here. Am I correct to believe I have to declare distributions as income (income tax payable) but when I sell units the base cost should be increased by the value of all distributions made during the life of the units, although the number of units is unchanged?
Hi Sarah, you are right that the number of units doesn’t increase, they increase in value by the amount of the dividend. Accumulation dividends do count as taxable income if not tax sheltered. But you pay that’s liable to income tax not capital gains. Therefore when calculating any CGT liability, the reinvested income should be deducted from the apparent gain to work out the true capital gain. If you don’t do that then you are taxed twice. Nasty.
Rob asked above if I had found the answer to my own questions. Yes, here are things I have discovered.
Firstly, so long as I transfer the fund to my spouse’s ownership before a dividend is paid, then that entire dividend will accrue to my spouse’s tax liability, even if I had been holding the fund for most of the previous accounting period. (My spouse will go forward with the same capital gains basis that I had.)
Secondly, funds (income and accumulation) can have their dividends paid with a so-called “equalisation” amount. This happens only in your first year of ownership of the purchased shares in the fund. The equalisation amount is a return of capital. It reduces the disadvantage of buying accrued dividends. The practical effect is that for an income fund your taxable dividend in this first year is decreased by the equalisation amount, and your cost basis (for your future capital gains tax calculations when selling) is also decreased by the equalisation amount. For an accumulation fund your taxable dividend in this first year is decreased by this amount, but the cost basis is unaffected.
Not all funds operate an equalisation regime. For example, Fundsmith Equity does not, whereas Vanguard FTSE all share does.
ETF and company shares also do not operate any equalisation. So if you buy an ETF/share just before its ex-dividend date, you are effectively buying the next dividend, which will be returned to you in just a couple weeks. This means you will incur a small amount of dividend tax on money that has not really been invested at all long. The equalisation regime operated by funds helps eliminate this infelicity.
Does anyone know how to find the tax reportable income for a Vanguard accumulation ETF such as “FTSE All-World UCITS ETF (USD) Accumulating (VWRA)”? One the Vanguard web pages I can find only information for the income version of this ETF, named VWRL, IE00B3RBWM25. Is one supposed to simply add up all the income reported for VWRL? See https://global.vanguard.com/documents/institutional/vf-plc-excess-reportable-income-30-june-2019.pdf
Hi Richard, I recommend asking Vanguard directly. They may tell you the Accumulating ETF doesn’t pay dividends.
Some Acc ETFs report distributions, some don’t. Why the non-reporting ones don’t, and whether that’s OK with HMRC is a mystery I haven’t got to the bottom of.
Investegate have a useful tool for discovering dividend announcements:
Company news > Advanced Search > Article type = Announcements, All Categories = Dividends, search by company name e.g. Vanguard.
Highly interesting article however I am confused.
I have owned units in the Vanguard Lifestrategy 60% Equity Accumulation fund for the past 12 months. I have used the following notional distribution per unit figure (https://www.trustnet.com/factsheets/o/acdq/vanguard-lifestrategy-60-equity) and thus calculated the gross distribution applied to my holding on 31/05/2019 (fund distribution date). I have subsequently used the notional distribution per unit figure as an off-set against gains when selling.
I spoke with a Vanguard representative to double check the notional distribution per unit figure from the Trustnet website. The representative could not provide this figure and thus requested that I contact my broker. Upon contacting my broker they too could not provide a figure however they did state the ACC fund class is not subject to dividend taxation. Is the broker correct?
I would be highly appreciative of anyone who may offer some clarity on this!
LearnFrench, isn’t there a 30 days rule as well if you sell and buy the same asset within 30 days it would tigger income tax not capital gain.
@Ramzez. It’s complicated. It depends whether you’re deemed to be carrying out a “trade” of dealing in securities. Trade = income tax (assuming not incorporated), non-trade = capital gains, except for dividends / coupons etc.
I suffered a bit doing the old tax return this time round as had to square away CGT on accumulating units (also had to muck about with ERI on ETFs which I begrudged as numbers turned out tiny). It was doable but not super pleasant.
I was lucky in that I got a bit of help from this community and an IFA mate to add some confidence that I was ‘doing the right things’, but what I did note while scouting around for assistance was another mate (20 years in investment banking) who confidently told me just buy acc units then you don’t have to worry about any dividend tax. There is a lot of confusion out there, even from those who you’d expect to have a handle on it.
@The Rhino — Absolutely. I didn’t actually know about this until @TA brought it to my attention all those years ago. I thought he was just being finickety! Set against that, who knows if/how often HMRC actually tracks anyone in the small fry category for non-payment. Also I’d hope most people have now got most of their funds in ISAs/SIPPs by now, so it’s clearly a minority concern.
For that minority (older, had a lot of assets perhaps in the old generous dividend allowance days, or anyone who comes into a lot of wealth suddenly) it remains a live issue though.
And yeah, aside from the fact that everyone should be paying their taxes due when they’re due (after taking any legal mitigation steps) you wouldn’t want to find HMRC calling after 20 years of compounded Acc unit reinvestment and asking to see your sums. The bill due might be less painful than the paperwork/hassle! 🙁
I always thought the easiest way to go was:
a) for DC/SIPP/ISA’s – use accumulation units; and
b) for taxable accounts e.g. GIA – use income units.
Tax reporting is then relatively straight-forward and any income needs can be met from dividends and/or selling units. If/when there are no income needs any dividends can be re-invested as and when and they may also assist with any re-balancing required.
What have I missed?
It’s exactly that reason I recommend to a) avoid Accumulation flavour b) avoid mixing up Dividends/Interest in the same fund (i.e. Lifestrategy) in GIA accounts or when investing through a limited company.
I find that Vanguard when investing directly (not via the online website) gives some very decent reporting by post. There’s a £100k minimum/fund though.
This is such a great and important article, thank you. I am fairly up on tax, but still struggle with this.
For a while I used to get the Acc Divis on my TR, but would forget to deduct them on Capital Gains.
I suppose if one wants to be really comprehensive (though it’s a separate issue from this), there is sometimes also Equalisation to deal with – for most people it will be a tiny sum, but I think this should be deducted from the Acquisition Cost when doing CGT calcs.
It is also not helped by the fact that so few online brokers do Accumulation Divi reporting (and even fewer do Excess Reportable Income…). It really should be mandatory.
In line with another comment are you sure this article is correct ? It seems ridiculously too complicated and impossible to enforce in reality surely below is the tax position
Income shares : you pay tax on the dividend in the tax year it’s paid out
Accumulation shares : you pay CGT only when you sell . The difference is simply the value you bought off the value you sellleaving the profit which includes the rise in share price plus any reinvested dividends ? Is the issue perhaps when you sell shares you don’t know this amount ? In my H&L account I get a read out of what they cost versus any profit or loss as total and percentage (which would include share price increase and reinvested dividend ) if I had £10k which had gone up by 10% would my cgt not simply be 10% of whatever I sell ?
My long term objective has always been to have the majority of investments in an ISA, to make life simple for myself in future especially as I get older. I don’t want to be doing CGT calculations and unnecessarily complex income tax returns when I get in to my eighties. I have just spent 2 weeks solid doing the CGT calculations on a relative’s portfolio after finding the ‘financial adviser’ had not ensured that my relative fully understood the possible CGT implications of selling the entire portfolio, which had remained static for a decade, and reinvesting in completely different funds. To make matters worse, units from one fund were sold each month to pay the horrendous fees and then the platform gave a rebate which was reinvested in the same units triggering the 30 day rule multiple times. The only plus point is that the platform did provide excellent transaction and tax records for the whole period. Not something that I would ever wish to repeat!
Interesting article and thread – thanks. I hold non tax sheltered acc units in funds (Vanguard LS) but given the complexity, potential for accidental mistakes and to make sure I avoid any CGT I tend to churn investments under the annual CGT allowance (and therefore don’t worry about the dividend adjustment in the CGT calc) for me and my wife with some then going into annual ISAs and some (if need be) going back into unsheltered funds. Obviously may mean a short time out of the market but incidental in the scheme of thing imho. This together with divi allowances and personal allowances (as mentioned) works for me. May not work for those with much bigger portfolios / gains / divi income of course.
I’m afraid that being “ridiculously too complicated and impossible to enforce in reality” doesn’t always stop something being written into the tax rules.
I came to the same conclusion as others, if only for the sake of simpler book-keeping: acc units in the ISA/SIPP; inc units in taxable accounts. Are there any major snags with that approach?
Very interesting article.
Is it OK to sell my unsheltered Vanguard Global All Cap (accumulation) and immediately buy Vanguard Global All Cap (income) or do I break the Capital Gains 30 day rule?
Are they classed as different funds or am I pushing my luck?
Possibly excess reportable income which TA mentions. For example, Vanguard declared for VWRL an amount of $0.1147 per unit in their June 2020 report. See https://www.vanguardinvestor.co.uk/content/documents/legal/vf-plc-excess-reportable-income-30-june-2020.pdf
@February I think this is set out in https://www.gov.uk/hmrc-internal-manuals/investment-funds/ifm16210, which seems to depend on whether it is a reporting fund or not. I researched this some time ago but never actually needed to rely on it. Something like pruadvisor or old mutual may have a more intelligible interpretation.
@February. There’s been lots of discussion on this elsewhere (https://forums.moneysavingexpert.com/discussion/comment/73461090#Comment_73461090) so I’ll let you read the arguments. In short though, maybe, maybe not. I wouldn’t. Can you bed and spouse?
I can’t see HMRC scouring trustnet to check that everyone’s telling the truth, if it’s hard for us to know or our brokers to know you can imagine what it must be like for hmrc. So as wrong as evasion may be you can bet that people are doing it, knowingly or not, if hmrc wants to collect on this (and to save us the hassle of checking) then they should regulate to make brokers keep track of dividends and capital gains (carried forward when switching) and tell both us and HMRC what incomes or losses were involved in a sale in a gia, then it can be down to us to declare anything else. If it’s automatic it might overall save hmrc manpower in investigating
I have a query. I have one fund in an unsheltered account.
I chose an income fund, based on advice from a previous post here, so this should simplify things.
I invested with a flat fee broker. From reading @FM’S experience with the platform selling to pay fees and the 30 day rule, I may have got lucky here with my choice of platform.
My choice of fund was LifeStrategy 80, chosen mainly so it didn’t need to be rebalanced. I’ve started to get a little concerned about the UK bias and I’ve realised I could have rebalanced by adjusting my ISA holdings to balance across the two accounts (GI/ISA).
My query is whether I’m likely to have tax return headaches with the split of equities/bond (dividends/interest) in the LS fund as briefly mentioned by @Foxy. Although @Matt the Newbie did mention that this was only an issue if bonds/cash are 60% or greater in with the fund. Do I also have to account for interest or just dividends?
Any thoughts/comments/experiences are greatly appreciated.
Just trying to nail down how to handle accumulating ETFs…
If I hold some VHVG (Vanguard FTSE Developed World UCITS ETF GBP Accumulating) I’m looking for the (notional) dividend and any ERI. Where do I look?
I have managed to find some data for the USD version (ISIN IE00BK5BQV03) in their UK Reporting Fund Status document (https://www.vanguardinvestor.co.uk/content/documents/legal/vf-plc-excess-reportable-income-30-june-2020.pdf) which shows no income but ERI of 0.8994 (presumably USD).
The equivalent distributing fund shows distributions of 1.1304 and ERI of 0.0733.
Is there effectively no dividend for the accumulating fund just the ERI? Or do I need to look somewhere else?
@Matthew and others, brokers statements cannot be relied upon and it would be impossible for them to properly work out your tax situation unless they knew everything about you. Simple example, lets say I hold an investment with 2 different brokers. When I sell part of a holding, what is the CGT liability? The broker cannot know that unless they know the combined cost of the holding across both brokers and any other gains made in the financial year. If the investment was then bought back at the other broker within 30 days, the calculation would be within the 30 day rule, which neither broker would know about.
Personally I prefer to hold income paying ETFs outside tax shelters instead of OEICS as OEICS have the extra complexity of equalisation payments to deal with. Excess reportable income does still need to be taken account of for income tax and CGT on disposal though. Swings and roundabouts, but that way I only have one type of anomaly to worry about.
@Tim Hughes, yes $0.8994 per share is your income, considered to have been paid on 31 December 2020. You need to convert that to pounds, which you can do using the official HMRC exchange rates here
Remember as well to add the excess reportable income into your cost of purchase to reduce your eventual CGT liability. With accumulating ETFs this may make a material difference.
In case you did not already know, these ETFs are offshore investments, so strictly speaking you need to include them into the offshore pages in your tax return. It makes no difference to your tax liability though as there is no withholding tax.
I have no problem handling the GBP/USD conversion, the ERI increase to base cost for CGT, and the offshore-ness (already having to cope with these for other investments…).
Just wanted to check there were no “internal” dividends as you’d get with Vanguard accumulating funds.
I think this article is wrong with regards to equalisation payments when it comes to calculating capital gains tax.
So my understanding is that a “total dividend” payment is split into 2 parts. The first part is the “real income” on which you pay dividends tax and the second part is the “equalisation payment” on which you don’t pay dividends tax.
“Real income” increases the cost basis of your purchase.
“Equalisation payment” decreases the cost basis of your purchase.
total_income = real_income – equal_paym =>
real_income = total_income + equal_paym
Therefore you calculate your capital gains tax the following way:
CG = Disposal_value – Total_Cost
= Disposal_value – (Acquisition_cost + real_income – equal_paym)
= Disposal_value – (Acquisition_cost + total_income + equal_paym – equal_paym)
= Disposal_value – (Acquisition_cost + total_income)
Hence for Accumulation funds you only need to remember to add the total notional income to your acquisition cost (which should also include transaction fees) and you can completely ignore equalisation payments.
Equalisation payments are only relevant for Distributing funds where you don’t add the “real income” of a dividend payment to your cost basis (since you actually receive the money).
In your example you essentially subtract the equalisation payment twice ending up paying an additional £100 in capital gains tax.
The following article agrees with what I said above as well:
Eh, I shouldn’t be typing when half asleep. I obviously screwed up the maths above since “total_income = real_income + equal_paym” !!!
However, the other article I linked to suggests that equalisation payments can be ignored on accumulation shares since you never receive the income. So I’m confused at this point.
Hi Illias – I read that piece along with several others including some very dull HMRC tax manuals when researching this piece.
It’s wrong to say “In your example you essentially subtract the equalisation payment twice ending up paying an additional £100 in capital gains tax.”
If you look at the income unit example in the article you link to they add the equalisation payment to the cost of purchase to increase the capital gain upon which tax is paid.
That’s because the equalisation payment is a return of capital that negates the part of the purchase price that was inflated by dividends to which you were not entitled at the time of purchase. The payment is designed so you pay the proper amount of capital gains i.e. more, not less because your purchase price included dividends you hadn’t earned because you didn’t own the fund as those divis rolled up.
There are a number of different ways of showing how it works which all get to the same place. I think the Abrdn example is just confusing because they just disregard the equalisation payment for acc shares. It makes life easier for whoever wrote that piece but I can send you links to alternative pieces that include fully worked accumulation fund examples for anyone who’s received notice of an equalisation payment for their acc fund.
As I say, there are different ways of calculating the same thing that all get to the same piece. I chose the one that I thought was clearest. Let me know if you’d like me to send you some of the links I mentioned.
You are absolutely right and I am wrong. And I think the accumulation example in the Abrdn page I linked to is wrong as well. They can’t just completely disregard the equalisation part.
A quick example I can think of to verify this is the following. Say you bought shares of an Acc fund just before the Ex-Dividend date and then you received a notional dividend of £100 a few days after that, where 100% of this dividend is the equalisation payment (since you bought just before XD date). Then you sell all your shares (assume the price didn’t move at all). If you disregard the equalisation payment and do the math the way the Abrdn link suggests (only accounting for notional income) then you could claim a £100 capital loss! Which of course doesn’t make sense. If you do the math the way you suggest then your capital gains is exactly £0, which makes sense.
The way I will be thinking about it is this. The book cost of your shares is increased by all notional income you received and decreased by all equalisation payments you received (which is exactly what you say in your article basically xD).
Please do send the links you mentioned!
@ Illias – your example is excellent and really helps illuminate what the equalisation payment is for. Thank you for that.
Here’s some links I found helpful. What complicates matters is that not all funds opt in to ‘full equalisation’ and HMRC guidance on accumulation units is vague.
Here is an example which hasn’t been covered to date and for which ‘I” have been unable to find a definitive answer or example for online.
Given that when this article was first posted online, the person who took out and sold the unit trust in the example you gave was still alive. I don’t know if that person is still with us but I know that persons cousin. He too took out a Unit Trust at the same time but unfortunately has now passed away. His personal representatives now have to figure something out and were hoping you could help. The details of which are laid out below:
Unit Trust Fund (Acc units) taken out by cousin of that person (now deceased)
– Dividends re-invested automatically after tax deductions.
– In possession of statements and Tax vouchers.
– Equalisation not applicable
– Unit Trust cashed-in(100%) during administration period by personal representatives
– No increase in the number of units
– Purchased for £10,000
– Date of death value for Probate is £16,000.
– IHT has been paid and the Unit Trust formed part of estate
– Net proceeds: £20,000
– Accumulated Income(net) till date of death is £3000
– Accumulated Income(net) from date of death till cash-in(100%) is £500
For your formula:
Capital gain = Net proceeds minus original acquisition cost minus accumulation income plus equalisation payments
– Original acquisition cost: is this £10,000 or £16,000 ?
– Accumulation income: Is this £3500 or £500 ?
1. How to calculate the Capital gain for this product by the personal representatives?
2. How to determine if CGT is due or not on gains on disposal of this Unit Trust ?
I think this article’s claim that “if you switch from accumulation to income units then that is a chargeable event” is wrong; it’s actually considered a “reorganization of capital”. Useful Reddit thread at https://www.reddit.com/r/UKPersonalFinance/comments/5eqkxz/tax_capital_gains_tax_on_converted_fund_from/ includes some links to HMRC guidance explicitly saying so. And here’s an MM article https://www.moneymarketing.co.uk/analysis/paul-kennedy-cgt-and-the-platform-sunset-clause/ which while it’s more about how swapping to clean priced units doesn’t trigger a chargeable event, it also mentions that “exchanges between accumulation and income classes of the same fund” are not disposals either. You do not necessarily have to have a platform or fund provider do a “switch” either; selling and re-purchasing is fine, so long as it’s done without unnecessary delay.
Trying again after a keyboard-mashing accident when I first tried to post this…
I think some of the confusion here comes from how brokers represent the information on tax statements.
As @TA says, the basic formula is:
(1) Capital gain = Net proceeds minus original acquisition cost minus accumulation income plus equalisation payments
Importantly, “accumulation income” here needs to be interpreted as the sum of the full dividends across the period you held for (i.e. the dividend that a long-term holder would have received, even if we’re talking about the first period that you held the fund).
We can rewrite this as:
(2) Capital gain = Net proceeds minus original acquisition cost minus (total accumulation income minus equalisation payments)
Adopting terminology from @Ilias, let’s define “real income” as the income subject to income tax. Then:
(3) Real income = total accumulation income minus equalisation payments
(4) Capital gain = Net proceeds minus original acquisition cost minus real income
Now, the source of some confusion I think is that some brokers’ tax statements tell you the “real income” and not the “total accumulation income”. Lloyds do that (and so I’d assume that Halifax and iWeb probably do too) and HL also do it. Not sure about other brokers.
**If** your broker has already calculated the real income for you, then as formula (4) shows, you don’t need to use the equalisation amount in your own calculations. In those circumstances, it’s sort of true that “equalisation payments can be ignored on accumulation shares” and that’s where that idea probably comes from.
Another thing that surprised me when I first learned it. The equalisation calculation isn’t personal to each investor – it’s common to everyone who acquired units during a dividend period.
At each ex-dividend date, unit holdings are classified as “Group I” (those that were held before the previous XD date) and “Group II” (those newly acquired since the previous XD date). A given investor (for example, someone who’s investing into the fund regularly) might have some units of both types.
Group I units receive all the income as “real income” (in the terminology used in earlier comments). Group II units get a mixture of “real income” and equalisation – but that mixture is the same for every holder of Group II units, whenever they were bought.
So let’s imagine we have a fund that goes XD on 1st March and 1st September. Eddie Early bought 1000 units of the fund on 2nd March, and Lisa Late bought 1000 units on 31st August.
On 1st September, a dividend of £1 per unit becomes payable. For Group II units, the fund manager calculates it to be split into 60p of real income and 40p of equalisation. Now, both Eddie and Lisa will receive £600 of real income and £400 of equalisation. In some sense, Eddie should have “earned” virtually £1000 of real income and Lisa should have “earned” virtually £0 – but that isn’t taken into account in the calculation.
(I should thank Hargreaves Lansdown, who patiently explained this to me in a situation where I was Lisa Late.)